Tax system and tax regulations

Saudi Arabia takes third place in the global list of countries ranked by ease of paying taxes, a remarkable achievement for a G-20 country with a GDP of over $700bn. Yet with the necessary due care and commitment to compliance, businesses can enjoy the advantages of the system.

The tax system in Saudi Arabia is basic but not simple. Tax regulations are fairly brief and their provisions are relatively clear in respect to items that they deal with directly. However, many areas remain open and subject to interpretation, and businesses should take a position on unclear areas and be prepared to defend their position during tax audits.

Requirements are reasonable but non-negotiable; for example, only one corporate income tax return per year is to be filed, but there are no deadline extensions or adjusted resubmissions (except for correcting arithmetic errors) without penalties.

Tax legislation can be characterised as stable. Taxpayers can comfortably plan their tax affairs and budget tax costs for the foreseeable future – an advantage that very few economies offer these days. The tax law was enacted in 2004, 11 years ago, yet it is commonly called the New Income Tax Law. The stability of tax rules is notable given the constant reforms in recent years in many other areas of society and business regulation, e.g., foreign investment, labour, immigration, finance and securities market.

However, although fundamental principles, tax rates and key concepts have remained unchanged, taxpayers have been witnessing and experiencing the introduction of amendments and additions to various parts of the tax rules. The overall objective of these changes has been to clarify grey areas in the rules and to close the gaps to ensure a consistent approach is applied in all similar cases.

The changes have been introduced in various forms: interpretations of the Department of Zakat and Income Tax (DZIT) in the form of their response to frequently asked questions posted on their website, decisions of appeal organs of various levels, changes to implementing by-laws and, finally, changes to the law itself. That said, in the near future taxpayers should expect to see more tangible changes to the rules, as follows: 
1. In accordance with the Ministerial Resolution No. 1776 of March 19, 2014, the DZIT has been tasked with developing guidelines on the application of transfer pricing (TP) rules already contained in the law. The resolution makes it clear that guidelines should be based on international practice. The DZIT website and other public sources of information reported that the DZIT had been in consultations on this subject with the OECD, accounting firms and other organisations that deal with taxation professionally. It is understood that the first draft of TP guidelines is already available and taxpayers should expect more scrutinised reviewing of their pricing with related parties in the near future.
2. Value-added tax (VAT) has been a topic of discussion in all GCC countries since 2011. Very little reliable data from public sources is available at present on timing, rate, territories (entire GCC or individual states), etc. However, if VAT is introduced there will, needless to say, be a material change for businesses and consumers. It will also be a new item to administer and collect for tax authorities, the complexity of which should not be underestimated, especially if VAT is introduced across the GCC.
3. And finally, the rules for zakat should soon be consolidated and codified in a single regulation document. Zakat is an obligatory payment originating from the religious rules of Islam. Originally, the requirements were addressed to individuals and only in recent times have rules for corporate zakat payers been developed. In substance it applies to the part of a business that is ultimately owned by KSA/GCC nationals. Given that most large business ventures in the Kingdom have a KSA/GCC partner represented by a Saudi state-owned entity or a KSA/GCC private businessman, most businesses are inevitably affected by zakat rules.

Introduction To The KSA Tax System

Saudi Arabia operates two parallel tax systems. Different tax regimes apply to companies owned by Saudi/GCC nationals and to the rest: resident companies owned by Saudi/GCC nationals are subject to zakat payment, all other firms pay corporate income tax.

Zakat liability for corporates originates from Islamic religious rules. Regulations require “looking through” Saudi resident companies to identify their ultimate beneficiary owners.

However, this requirement does not extend to foreign holding companies located outside of the GCC. In other words, if a Saudi company (or group) is owned by an entity outside of the GCC, irrespective of the nationality of the ultimate beneficiaries, this Saudi company will normally be subject to corporate income tax.

The choice of tax system depends only on taxpayer’s ownership structure; no other factors – e.g., type of activity, industry of operation, geographic location, etc. – have any impact.

“Mixed companies”, i.e. companies jointly owned by Saudi/GCC national(s) and foreign individuals/entities, are subject to both zakat and corporate income tax, applied to the respective shares of shareholders in the business.

Foreign companies that have created a permanent establishment (PE) in KSA are subject to corporate income tax via self-assessment in a manner similar to Saudi companies; foreign companies that earn income from Saudi sources without creating a PE are subject to tax by way of withholding.

All corporate employers are liable for their share of social insurance contribution.

There are no other corporate taxes in KSA.

The DZIT is the government body responsible for the implementation of policies, the collection of dues and ensuring compliance by zakat/taxpayers.

The General Organisation for Social Insurance (GOSI) has similar responsibilities for social taxes.

Certain Updates On Zakat Regulations

The new draft zakat regulation was approved by the Shura Council in June 2014. It includes certain changes to the basis of zakat computation as compared to the current practice, which is likely to be changed further before the regulation comes in force. Some salient features of draft regulations are:

• It will apply to: 
1. Resident natural Saudi/GCC individuals;
2. Closed investment funds (treated as capital companies);
3. Owners of properties available for sale or rent;
4. Charitable societies and non-profit organisations are exempted from zakat; and
5. Properties, real estate and land held for trading or leasing purposes, including vacant or developed land owned by individuals and business entities, will be subject to zakat.

• Zakat base computation will be shifted from its current focus on equity and long-term assets/ liabilities to a working capital basis.
• There are some items which will be included in zakat, for example receivables, stock of goods and raw materials and so on. Deduction from the zakat base will be available for liabilities connected to the zakatable base.
• It is proposed that zakat will be computed at 2.577% for companies following the Gregorian year (as against 2.5% for companies following the lunar year). Further, zakat payers will be allowed to pay up to 20% of their annual zakat liabilities to registered charitable institutions and societies that are authorised to receive zakat.
• A delay penalty of between SR100 ($26.65) and SR25,000 ($6662.50) per year is proposed to be imposed for not filing zakat returns on time (i.e. within 120 days of the year-end).
• It is proposed to levy a zakat evasion penalty of twice the zakat due, whereby the zakat payer and certified public accountant (CPA) are jointly liable for the penalty settlement.
• Zakat and tax advisors may be required to certify the returns if the capital is SR500,000 ($133,250) or more and/or if revenue for the year is SR5m ($1.33m) or more.

Overview Of Corporate Income Tax Regime 

Corporate income tax rules are governed by the Income Tax Law (Tax Law), which came into force in 2004. The Tax Law is supplemented by implementing regulations (By-Laws).

In addition, the Ministry of Finance issues resolutions concerning tax and zakat, and the DZIT regularly issues circulars and responses to frequently asked questions containing its interpretation/position on various parts of the tax system.

Tax administration and enforcement practices in the Kingdom can be characterised as being both substance and form driven. The tax authorities may (and often do) scrutinise transactions to understand their substance and may challenge taxpayers if they view transactions as tax driven. At the same time, documentation (contracts, invoices, etc.) and supporting transactions have to be in place and accurately reflect the taxpayer’s intent and the substance of the transaction. The authorities may choose to base their judgement and conclusion on the provision of documentation only; for example, extended description of activities in a cross-border service contract may be sufficient to claim creation of a PE even if the in-country component of the service has not in fact been delivered.

International Agreements: Generally, provisions of international agreements to which KSA is a party prevail over the provisions of domestic tax legislation. An exception to such provisions is made under the anti-avoidance rules contained in Article 63 of the Tax Law (please see further discussion in the Double Tax Treaties section below).

Tax Accounting: The tax system is mainly based on financial accounting and reporting, which should be based on Saudi Generally Accepted Accounting Principles (GAAP) – standards issued by the Saudi Organisation of Certified Public Accountants. The Tax Law sets its own rules with respect to some specific areas, e.g. depreciation method, accounting for long-term contracts, etc.

The Saudi riyal is the currency for tax accounting. The tax year is a Hijri calendar year (i.e. lunar year). The Gregorian calendar year or a different calendar tax year may be used, with the latter being subject to certain restrictions.

Books must be maintained in country and in the Arabic language. Persons Subject to Tax: Under the Tax Law, the following persons are defined as subject to tax in KSA:

• A resident capital company in respect of the shares of non-KSA/GCC nationals;
• A resident non-GCC individual who conducts business in KSA;
• A non-resident who conducts business in KSA through a PE;
• A non-resident with other taxable income from sources within the KSA;
• A person engaged in the field of natural gas investment; and
• A person engaged in the field of oil and hydrocarbons production Tax Residents: A natural person is resident in KSA if one of the following conditions is met:
• He/she has a permanent place of residence in KSA and resides in KSA for at least 30 days in a tax year; or
• He/she resides in KSA for at least 183 days in a tax year without having a permanent place of residence. A company is considered resident in KSA if one of the following conditions is met:
• It is formed in accordance with the KSA Companies Law; or
• Its central management is located in KSA.

Taxable Income & Tax Base: Generally, taxable income is the gross income including all revenues, profits or gains of any type and of any form of payment resulting from carrying out an activity, including capital gains and any incidental revenues less exempted income.

The Tax Law provides that income from the following specific types of activities/sources is considered taxable in KSA:

• Use of licence in KSA for industrial or intellectual properties; this category of income also covers software licences;
• Activities within KSA;
• Immovable property located in KSA, including gains from the disposal of an interest in such immovable properties;
• Disposal of shares in a resident company or a resident partnership;
• Lease of moveable properties used in KSA;
• Dividends, management fees or director’s fees paid by a resident company;
• Services rendered by a resident company or PE to the company’s head office or to an affiliated company;
• Payments made by a resident for services performed in whole or in part in KSA; and
• Income of a Saudi PE.

Taxpayers are required to prepare financial statements under Saudi GAAP and are expected to have them audited. Net income according to those financial statements, as adjusted for tax purposes, is the base subject to corporate income tax.

Tax Rates: Standard corporate income tax is charged at a flat 20% rate.

A special 30% rate applies to income of taxpayers engaged in only “natural gas investment activity”. Another special 85% rate applies to income from production of hydrocarbons.

Non-residents (who do not have a branch or PE) deriving income from a Saudi source are assessed withholding tax (WHT) at 5% to 20%, depending on the nature of the income derived. This is discussed further in this article.

There are a number of WHT rates applicable to income from sources in KSA discussed further in this article.

Loss Carry-Forward: Tax losses may be carried forward indefinitely until fully utilised. Deduction of tax losses is limited and should not exceed 25% of the tax base of a particular year.

In the event of a change in control of 50% or more of the shares or voting rights of a taxpayer, all carried-forward losses will forfeit. Loss carry-backs are not allowed.

Based on our recent tax audit experience, the DZIT has been disallowing the off-set of carry-forward losses which were incurred in the initial years of setting up of a company and where the revenue is nil. The DZIT believes that since the company did not generate revenue during such period, the cost incurred is pre-operative in nature and does not meet the expense deductibility criteria as per the By-Laws of the Tax Law.

Further, we are aware of a case where the DZIT has disallowed the off-set of losses against the taxable profit generated as a result of the tax assessment of a particular year (i.e. wherein the company originally had losses as per the tax return) based on the general reading of Article 11 of the By-Laws, which states the maximum profit that can be used to offset cumulative losses should not exceed 25% of the year’s profit as reported in the taxpayer’s return (and not as a result of tax assessment).

Thin Capitalisation: There is no special legislation governing thin capitalisation for tax purposes. A Saudi entity may deduct interest payments to affiliates, but not to the head office, provided that the amount of debt and rate of interest are at arm’s length and that the interest deductibility formula (mentioned below) is met. Banks are excluded from the application of the above regulations. A Saudi entity may be financed with minimum capital, and there is no limit to the amount of debt that may be used. The DZIT generally does not challenge the capital adequacy of a company.

The deduction of interest expense is limited to the lower of the actual expense or interest income plus 50% of the taxable income before interest income and interest expense. Interest (or loan fees) in excess of the deductibility limit set out above is a permanent disallowance under the Tax Law and its By-Laws.

Additionally, in accordance with the companies regulations, if the accumulated losses of a company exceed 50% of its share capital, a shareholders' meeting must be called to determine whether to continue the business. This resolution must be published in the Official Gazette. Permanent Establishment: Saudi tax law defines a PE as “a permanent place of the non-resident’s activity through which it carries out business, in full or in part, including business carried out through its agent”.

The following constitutes a PE:

• Construction sites, assembly facilities and the exercise of supervisory activities connected therewith;
• Installations, sites used for surveying natural resources, drilling equipment, ships used for surveying for natural resources as well as the exercise of supervisory activities connected therewith;
• A fixed base where a non-resident natural person carries out business;
• A branch of a non-resident company licensed to carry out business in the Kingdom; and
• Holding an interest (share) in a KSA resident partnership.

It should be noted that even though the Tax Law and the By-Laws address the definition of a PE, neither of them addresses the period/threshold of onshore presence which leads a non-resident entity to qualify as a PE in Saudi Arabia. In practice, the DZIT has accepted certain activities lasting up to three months as not creating a PE; there are cases when the DZIT has even accepted six months.

The DZIT has recently begun applying the concept of “virtual” PE, in which it establishes a PE for the non-resident entity even if there was no presence required (i.e. services provided offshore), as long as the term of the services exceeds the threshold. This is a relatively new practice and it is currently being challenged.

Article 4 of the By-Laws specifies that the dependant agent is someone who has any of the following authorities:

• Negotiate on behalf of the principal;
• Conclude contracts on behalf of the principal;
• Has a stock of goods, owned by the principal, on hand in KSA to supply customers on behalf of the principal;
• Insurance/reinsurance agent (even with no powers to negotiate). Deduction of certain inter-company transactions is limited for PEs.

After-tax profit of PEs is subject to an additional 5% upon repatriation. The Tax Law states that this tax applies upon actual or deemed repatriation.

Withholding Tax: Income of non-residents from KSA sources is subject to WHT if they do not have a PE in the country. A KSA person or a PE of a non-resident (tax agents) making a qualifying payment to a non-resident is responsible for withholding the applicable tax.

The types of income and applicable WHT rates are laid out in the table below.

Supply of equipment and goods is not subject to WHT. However, Customs documents are crucial to claim tax deduction as well as proof for the authorities that such supply does not include revenue from any service element.

The Tax Law specifically assigns responsibility for withholding to tax agents, and it imposes penalties on tax agents for failure to withhold, pay or report to the DZIT.

However, the Tax Law further states that the “beneficiary” remains liable in case tax is not withheld and the DZIT may recover the tax from the “beneficiary or its agent or sponsor”.

Tax agents should report to the DZIT on their tax withholding and pay the withheld tax to the DZIT within the first 10 days following the month of payment to a non-resident.

Similar to income tax, tax agents should submit an annual report on WHT within 120 days after the tax year-end.

From October 2014, the DZIT required WHT returns to be filed online. Tax/zakat payers are required to register an account on the DZIT's website (dzit.gov.sa).

WHT forms are completed and submitted online and a receipt number is generated which is then used to make payment through the online SADAD system only (the DZIT has stopped accepting payment by cheque).

Full or partial relief may be obtained by applying bilateral tax treaties. Please refer to the following section for further details. Double Tax Treaties: Around 30 Saudi double tax treaties (DTTs) are in force and the tendency is to continue signing double tax avoidance agreements to promote foreign investments and allow for a more competitive and internationally accepted taxation regime in the Kingdom. Saudi DTTs generally follow the OECD model treaty.

The benefits of these tax treaties vary among countries and specific items of income; some treaties provide a reduced rate or exemption from WHT on royalties, dividends and interest, while others provide limited relief from capital gains tax. Refund or Automatic Application under DTTs: Under the DZIT’s earlier circular, the KSA service recipient is required to withhold and pay tax at the rates applicable under domestic tax law. Where a lower rate or exemption applies as a result of applying the articles included in a DTT, the withholder is required to claim for a refund of the WHT paid.

In doing so the KSA resident is required to submit the following documentation:
1. Letter from the withholder certifying and explaining that WHT should not apply under a DTT;
2. Request from the non-resident recipient to claim refund;
3. Tax residence certificate of the recipient;
4. Copy of the WHT form;
5. Copy of a bank receipt showing the amount of WHT paid to the DZIT;
6. Completed refund request form; and
7. Certificate of registration of the withholder.

In the year 2013, the DZIT issued a new circular regarding certain amendments in the procedure of claiming tax treaties’ benefits as provided in the previous circular. The DZIT usually requests other documentation in order to verify that the conditions under the treaty are met, such as agreements, articles of association, etc.

Based on the new circular, the Saudi Arabian entity making a taxable payment to a non-resident entity can apply the provisions of effective tax treaties if it complies with the following requirements: 1. Reporting of all payments to non-resident parties (including those payments which are either not subject to WHT or are subject to WHT at lower rates as per the provisions of effective tax treaties) in the monthly WHT returns in Form No. K7/A;
2. Submission of a formal request for application of effective tax treaties’ provisions in Form No. K7/B, including a tax residency certificate issued from the tax authorities in the country where the beneficiary is residing confirming that the beneficiary is resident in that country in accordance with the provisions of Article 4 of the treaty, does not have a PE in Saudi Arabia and that the amount paid is subject to tax in that country; and
3. Submission of an undertaking in Form No. K7/C from the Saudi Arabian entity that it would bear and pay any tax or fine due on the non-resident payees due to incorrect submitted information or a computation error or misinterpretation of the provisions of a tax treaty (on a prescribed format).

It is also mentioned in the above circular that Saudi Arabian entities that cannot comply with the abovementioned requirements may follow the procedure provided in the previous circular (i.e. payment of WHT at the rates prescribed in Saudi Arabian tax regulations and claiming the refund of overpaid taxes on the basis of provisions of tax treaties).

As the new circular was issued recently, there is little practical experience with respect to applying for exemptions available under the DTT in accordance with the new circular. There are also a number of issues which are currently being addressed and discussed with the DZIT concerning the procedures laid down in the circular – for example, the requirement to obtain a statement issued by tax authorities confirming that the recipient of the income does not have a PE in Saudi Arabia.

As there is a degree of uncertainty in applying for treaty benefits under the new circular, many Saudi Arabian entities continue to withhold tax and seek a refund as prescribed under the previous circular. Capital Gains: No special tax treatment exists for capital gains; they are added to the total taxable income of KSA taxpayers.

Capital gains received by non-residents from the disposal of shares in KSA-resident companies are subject to tax at 20%. Under the new ministerial resolution, the seller is liable to notify the DZIT of the sale/disposal and pay the due taxes within 60 days from the selling date, and the purchaser is jointly responsible with the seller to pay any capital gains tax due to the DZIT as a result of such sale. Accordingly, the company whose shares are being disposed of is no longer responsible for the settlement of capital gains tax.

Tax Compliance & Payments 

Resident Taxpayers & PEs: Taxpayers must file one return per year. Returns with taxable income exceeding SR1m ($266,500) before deductions should be certified by a KSA certified public accountant.

Corporate income tax returns should be filed within 120 days after the tax year-end. Taxpayers should be aware that a lot of preparatory paperwork should be ready for filing together with the tax return. This paperwork includes, without limitation, (audited) financial statements, GOSI certificate, breakdown of all purchases, an annual WHT form, breakdown of repair/maintenance costs, details of changes in shareholding (including copies of sale-purchase agreements and updated commercial registration and licence), etc.

The resulting tax liability should be settled by the filing deadline, i.e. 120 days after the end of tax year. Taxpayers should make three quarterly advance tax payments at the end of the sixth, ninth and 12th months of the financial year, unless it is the first tax year or the amount of tax liability for the preceding year is less than SR2m ($533,000). Penalties & Fines: Non-registration of a taxable entity, late filings and late payment of taxes due are potentially subject to penalties.

Delay in payment triggers a penalty at 1% of the unpaid taxes for each 30 days of delay.

Failure to file the income tax return by the deadline could potentially attract the greater of:

• 1% of the gross revenue up to SR20,000 ($5330); or
• Between 5% and 25% of the underpaid tax.

Delay in payment of WHT is subject to a penalty of 1% of unpaid tax for every 30 days of delay. The penalty is, however, not cumulative, so one should expect to pay 1% for each month of delay.

After the implementation of online filing, the online system of the DZIT calculates the delay fine for late filing, although the tax liability may have been settled on or before the due date. In order to reverse such a delay fine, an application is required to be submitted along with payment proof.

In addition to the above penalties, a taxpayer may also be subject to a fine of 25% on the difference of tax paid and tax due where that difference is a result of fraud or false information provided by the taxpayer or its certified accountant. Statute of Limitations for Tax Assessment: The general statute of limitations for the DZIT is five years and 10 years in cases where the tax return was not filed, or if filed, was found to be incomplete or incorrect with intent of tax evasion.

Overview Of Zakat Regime

Legal Base: The roots of the existing KSA zakat system go back to the requirements of Islamic rules to share (excess) wealth and growth of it in certain specific types during the “reporting” year.

Zakat rules are largely un-codified. There are ByLaws issued by the DZIT that cover procedural matters, but zakat is mainly governed by fatwas, the pronouncements by religious authorities.

However, as stated earlier, the DZIT is in the process of issuing new zakat regulations. These regulations will enter into force after the approval of the Council of Ministers and the Commission of Experts; such approval is not expected to take more than two years. These regulations are still in draft status, and there may be further changes made before the issuance of the final regulations. Persons Subject to Zakat:

• Saudi individuals or nationals of GCC states who conduct business in the Kingdom; and
• Saudi resident companies of all types owned by Saudi nationals, including shares of Saudi/GCC nationals in mixed companies.

Zakat Base: Zakat base is the higher of net adjusted profit (determined in similar manner as the income tax base) or “net worth” determined as explained in the table on the previous page.

Zakat payers are advised to carefully review all relevant rules and fatwas before taking a position on any particular issue. Zakat Rate: Zakat liability is calculated by applying a 2.5% rate to the zakat base. No statute of limitations: Given that zakat is a religious duty on individuals, no regulation contains direct provision with a statute of limitations.

GOSI System

Legal Base: Social taxes and activities of GOSI are governed by the Social Insurance Law, as supplemented by implementing regulations. Employers should contribute to monthly GOSI occupational hazard insurance at the rate of 2% of the employees’ ( foreign and Saudi nationals) salaries (i.e. the GOSI base), provided that they are under the sponsorship of the reporting entity.

The GOSI base generally consists of the monthly base salary and cash housing allowance of an employee. However, if housing is provided in kind, the amount to be included for GOSI purposes is computed as two months of the basic annual salary.

In addition, there is also a mandatory contribution to annuities insurance, which is calculated on the following basis:

• 10% – employer’s contribution on Saudi employees’ income; and
• 10% – Saudi employees’ contribution. Saudi employees’ contribution is calculated, withheld from salary and paid to GOSI by the employer.

Also, it should be noted that the minimum monthly salary used to calculate contributions is SR1500 ($400) and the maximum monthly salary used is SR45,000 ($12,000).

Customs Duties

The GCC established a common external tariff of 5 % for most imported goods. There are no other duties or taxes for products going to Saudi Arabia.

Saudi law prohibits importation of the following products: weapons, alcohol, narcotics, pork, pornographic materials, distillery equipment and certain sculptures.

Other Taxes

There is no form of stamp duty, transfer pricing, excise, sales, turnover, production, real estate, property or other material taxes that currently apply to businesses in KSA.

Tax Status Of Individuals In KSA

Both the Tax Law and zakat regulations mention individuals as payers of respective payments.

Income Tax: A number of articles of the Tax Law contain references to individuals.

As indicated in the corporate income tax part above, persons subject to tax include:

• A resident non-GCC individual who conducts business in KSA,
• A non-resident with other taxable income from sources within the KSA, Tax residents include:
• He/she has a permanent place of residence in KSA and resides in KSA for at least 30 days in a tax year; or
• He/she resides in KSA for at least 183 days in a tax year without having a permanent place of residence.

Further, the definition of “activity” in the Tax Law, income from which is subject to tax in KSA, is quite broad and also contains types of activity that would be undertaken only by individuals: an activity is a commercial activity in all its forms, or any vocational, professional or other similar activity for profit.

However, in practice the Tax Law has never been interpreted and enforced to charge income tax to individuals. Irrespective of duration of stay and status of residence, to date employment income of individuals has remained free from taxation in KSA.

That said, tax agents will deduct tax from income subject to WHT even if it is paid to individuals. Zakat: As per the original rules of Islam, zakat is the responsibility of an individual. Application of zakat on corporates is seen as the “help” by the government to individuals to fulfil their obligation.

However, similar to income tax, the Saudi Arabian authorities do not enforce the rules to ensure compliance by individuals. In practice, only corporate zakat payers have the responsibility to meet the requirements before the DZIT.